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After Strong First Half, Should Investors Sell Stocks?

A late rally for stocks this week helped stock investors end the first half of 2011 with gains.

The Federal Reserve headquarters in Washington, DC.
The Federal Reserve headquarters in Washington, DC.

The Dow finished the first half higher by 7.2 percent following a small positive gain for the second quarter due to a late June rally.

Earlier this week Larry Fink, the CEO of Blackrock told CNBC that he would hold 100 percent of his money in stocks if his accountants would let him, indicating he was yet to see any value in the fixed-income markets amid fears over the euro zone’s periphery and yields on the US 10-year bond sitting at just three percent.

“As financial market sentiment was overly pessimistic at the end of the second quarter and our tactical market sentiment indicators sent several buy signals, we expect to see a recovery at the beginning of the third quarter,” Philipp E. Baertschi, the chief strategist at Sarasin in Zurich wrote in a research note.

Despite seeing reasons to buy, Baertschi is looking to reduce the amount of risk in his portfolio.

“We have reduced the commodities weighting and the overall portfolio risks. If stocks rally, another reduction in equities might be needed here as well,” he said.

“Although we expect to see a technical recovery in the stock markets at the beginning of the third quarter, the risks to equities this summer remain high.”

“We think corporate earnings estimates will have to be revised sharply downwards. It will only become clear in autumn whether the global economy can pick itself up after the dip in growth,” Baertschi added.

The second quarter earnings season could be one of the most interesting in years, with other analysts questioning the outlook for corporate profits.

One reason “we doubt the rally in the stock market will last is that we think the outlook for corporate earnings is less favorable than many assume” John Higgins, the senior market economist at Capital Economics said in a research note.

“Profit margins have certainly risen since the end of the recession, but the scope for a further rise is limited at this stage of the business cycle,” he added.

With the Federal Reserve's second round of quantitative easing finishing and little chance of QE3 being signed off by the Fed, stock valuations are stretched, according to Higgins.

“We continue to expect the S&P 500 to drop back to 1,200,” he wrote.

“Valuations remain stretched. At 22.7, the cyclically-adjusted price/earnings ratio of the S&P 500 is well above its long-run average since 1900 of just below 15. Of course, there is no reason why equities cannot become even more overvalued. However, we think investors’ appetite for risk is less likely to wax than to wane.”

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